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U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
Remarks Before the Aspen Institute Italia Seminars for Leaders


Commissioner Cynthia A. Glassman

U.S. Securities and Exchange Commission

Cernobbio, Italy
November 7, 2003

Good morning. Thank you all for inviting me to participate in this important program. Before beginning, I need to give the customary disclaimer that the views I express today and throughout this program are my own, and do not necessarily reflect the views of the Commission or its staff.

In the United States, having experienced several major corporate scandals, we are asking fundamental questions about our markets and how they function. Many of the corporate governance protections companies had in place did not prevent large-scale fraud from occurring. The title of this seminar, "The challenges of capitalism and the role of business," highlights similar fundamental concerns in markets throughout the world.

In the United States, we have tried to deal with the recent scandals in a forthright and transparent manner. Only by dealing with these issues in the open will we be able to take the hard look at the scope and degree of the problems that is necessary to come up with appropriate solutions. Experience shows that neither markets nor investors benefit if we try to minimize or hide the true scope or nature of the issues.

In some respects, the current business environment is part of the necessary and painful process of dealing with excesses that occur periodically in free markets. Unrealistic optimism - for example, about how the Internet would change business fundamentals - led to unrealistic expectations among investors. In the recent corporate scandals, a bad situation became worse because company executives were handsomely compensated based on meeting those expectations - no matter how unrealistic they became. These factors increased pressure on executives to engage in financial engineering to maximize reported short-term profits, even if it meant sacrificing long-term shareholder value. As companies struggled to keep up with expectations, they could only go so far by taking legitimate business risks. So they started taking illegitimate regulatory risks, such as using misleading accounting. As can sometimes be the case, success breeds excess.

In response to the corporate scandals, the United States Congress and the President passed the most sweeping reforms of corporate governance since the early 1900s. It is fair to ask whether the recent scandals were so different from prior corporate abuses that they warranted such a response. I believe that they were. Among the differences from prior scandals were the increased number of American families who invest some portion of their savings in the securities markets, and the degree to which employees concentrated their wealth in their employers' stock. Another difference is the degree to which a broad range of the professionals who are supposed to serve as a check against large-scale fraud failed to perform their duties. These factors put a much higher premium on prevention as a regulatory goal.

I do not have enough time to discuss the individual provisions of Sarbanes-Oxley, so for the sake of being brief I will focus more on what I see as the themes of the legislation. The spate of corporate scandals revealed weaknesses in the way corporations approached governance - weaknesses the legislation was aimed at correcting. In Sarbanes-Oxley, Congress directed the Commission to adopt rules to increase the accountability of chief executive and financial officers, improve the quality of financial reporting, and raise professional, legal and ethical standards for the gatekeepers in our financial system.

As I view it, the Commission's role in implementing the legislation is to ensure a level and fair playing field by writing rules that provide incentives to do the right thing, and enforcing them vigorously when the rules are broken. The overriding purpose of SEC rulemaking is to ensure that there is an environment in which investors are protected, and the markets can allocate resources efficiently.

That is the general approach of Sarbanes-Oxley and the Commission's rules. For the most part, the new rules seek to enhance the effectiveness of existing private checks on corporate abuse - such as lawyers, analysts, boards of directors and other so-called "gatekeepers." Practically speaking, regulators cannot be everywhere, so insofar as we value prevention as a goal, we have to continue to rely on the system of private checks and balances known as corporate governance. To that end, Sarbanes-Oxley clarified and imposed new duties on companies and the private sector "gatekeepers" to help prevent similar failures by them in the future.

Sarbanes-Oxley also enhanced oversight of these gatekeepers in some important areas. In the area of auditor oversight, for example, Congress ended the prior system of self-regulation by creating a new independent regulator to oversee the accounting industry.

In the interest of setting up the discussion, I would like to highlight what I see as a few of the lessons that we can take away from the recent corporate scandals and the regulatory response to them.

First, as painful as the past few years have been, there are positive signs that markets are dealing with corporate excesses. Investors are being more selective with their capital. They are rewarding companies that have solid fundamental business prospects and good governance, and punishing those that do not. Sarbanes-Oxley was a necessary and appropriate response to the corporate scandals. It provides incentives to help the markets work effectively, and will help to ensure that all market participants play by the rules. But we have to let the markets work, and passing new laws and rules is not always the answer. We also need to be careful that the rules we pass in the name of saving capitalism do not have the opposite effect.

Second, regulators and investors both need to understand that without risk there is no progress. Risk, therefore, is a necessary part of running a business or investing in one. There is a limit to how far we can go toward reducing risk consistent with free markets, while still keeping them free. If we try through regulation to eliminate, or even minimize, risk, we are likely to stifle innovation, increases in productivity and economic growth. To use an analogy, few people would think it was a good idea to outlaw wine in order to prevent hangovers - especially in Italy.

Third, it is harmful to investors and the markets themselves if our rules impose unnecessary burdens that prevent legitimate companies from accessing the public markets. Excessive regulations that impede progress and artificially restrict investor choices can be just as harmful as corporate excesses.

Finally, many people in my country are already asking whether Sarbanes-Oxley worked. In my opinion, at this point it is still far too early to tell. The SEC only passed most of the rules required by the Act less than a year ago, and some have not even taken effect yet. I think the Act has had a positive effect in terms of raising corporate consciousness, and reminding gatekeepers of the important role they play in ensuring legal and proper corporate conduct. Only if our markets remain fully transparent will they be able to attract companies and investors. How successful the new rules are will be measured by companies and investors in their decisions on whether to commit capital or access the public markets. To put it another way, ultimately the market will decide if the new rules are a success.

What I hope we, as a Commission, have accomplished with our rules and public statements is a heightened consciousness on the part of all market participants that we have had some serious breakdowns, that failures occurred on many different fronts, and that everyone must now be part of the solution. Companies must improve their governance, disclosure must be clearer, gatekeepers must be more independent and diligent, investors need to be better informed, and regulators need to be more proactive.

With that, I will conclude my remarks, and turn it over to the distinguished members of the panel to discuss these important issues.



Modified: 11/21/2003